Copyright © 2014 Nelson Education Ltd. 12–1 PowerPoint Presentations for Finance for Non-Financial Managers: Seventh Edition Prepared by Pierre Bergeron

Copyright © 2014 Nelson Education Ltd. 12–1

PowerPoint Presentations for

Finance for Non-Financial Managers:

Seventh Edition

Prepared by

Pierre BergeronUniversity of Ottawa


CHAPTER 12

Business Valuation


1. Differentiate between market value and book value.

2. Discuss valuation models.

3. Comment on what it means to scan the environment.

4. Explain how to document planning assumptions.

5. Show how to restate the statement of income and the statement of financial position.

6. Present ways to price an ongoing business.

7. Calculate the market value of publicly traded companies.

8. Determine the investment return on capital projects from an investor’s perspective.

Learning Objectives


Book Value versus Market Value

Statement of Financial Position(based on book value)

Statement of Financial Position(based on market value)

House

Original cost $ 200,000

Accumulated

depreciation (100,000)

Book value $ 100,000 New mortgage $ 200,000

House

Market value $ 400,000 New mortgage $ 200,000

LO 1


Valuation Models

Book value

Market value

Liquidation value

Industry multipliers

DCF method

Going-concern value

Economic value Replacement value

Assessed value

LO 2


Scanning the Environment

Method used during the planning process to pin down planning assumptions or premises

General Past

Present

Future

Statement

of income

Statement

of financial

position

Scanning the environment

(SWOT analysis)

Documenting the planning assumptions

Restating the financial

statements

Industry

Examples of planning assumptions: GNP, labour rates, market demand, supply capability, unemployment, interest rate, price for raw materials, competitive climate, consumer profile, etc.

Price-tagging the business

LO 3


Documenting Planning Assumptions

• Planning assumptions are used to prepare a company’s projected financial statements

LO 4


Documenting Planning Assumptions

• Typical planning assumptions related to the statement of financial position:– Non-current assets:

• assets to be purchased, composition of non-current assets, amount to be invested in new assets, modernization, expansion, assets to be sold, depreciation and CCA rates for different non-current assets

– Current assets: • cash in bank to meet on-going activities, composition of prepaid

expenses, aging of trade receivables, estimated bad debts, inventories in raw materials, work-in-process and finished goods, holding costs, ordering costs

Continued…

LO 4


Documenting Planning Assumptions (concluded)

– Equity: • number of shares outstanding, dividend policy

– Long-term borrowings: • amount outstanding, cost of debt, nature of

agreements– Current liabilities:

• payment policies, terms required by suppliers, amount outstanding and interest rates, nature of accruals

LO 4


Restating Futurama’s Statement of Financial Position (Slide 3-7)

Non-current assets (at cost)Accumulated depreciationNon-current assets (net)Goodwill

Current Assets Inventories Trade receivables Prepaid expenses CashTotal Current Assets

Total Assets

Common Shares

Retained Earnings

Equity

Total Long-term borrowingsCurrent Liabilities

Trade and other payables

Notes payable Accrued expenses Taxes payableTotal current liabilities

Total Liabilities

Total equity and liabilities

$ 3,000,000400,000

170,000250,000

195,000

$ 1,340,000 140,000 1,200,000

-------

218,000

300,000

60,000

22,000

600,000

$ 1,800,000

$ 300,000

255,000

555,000

800,000

195,000

150,000

20,000

80,000

445,000

1,245,000

$ 1,800,000

Total $3,625,000

LO 5


Restating Futurama’s Income Statement (Slide 3-8)

Revenue $ 2,500,000

Cost of sales (1,900,000)

Gross profit 600,000

Salaries (300,000)

Rent (50,000)

Depreciation (40,000)

Other expenses (15,000)

Total expenses 405,000

Profit before taxes 195,000

Income tax expense (97,500)

Profit for the year 97,500

Add back depreciation 40,000

Total cash flow $ 137,000

$ 4,000,000

$ 369,000

$ 150,000

$ 519,000

LO 5


Book Value Method—Futurama Ltd. (Slide 3-7)

Book Value

Assets

Non-current assets $ 1,200,000

Inventories 218,000

Trade receivables 300,000

Prepaid expenses 60,000

Cash 22,000

Total assets $ 1,800,000

Equity

Liabilities

Trade and other payables 195,000

Misc. loans 1,050,000

Total Liabilities 1,245,000

Total equity and _________

liabilities $ 1,800,000

Difference between assets and liabilities

Book value

$ 555,000

LO 6


Liquidation Value Method

Liquidation ValueAssetsNon-current assets $ 900,000Inventories 150,000Trade receivables 200,000Prepaid expenses -------Cash 22,000Total Assets $ 1,272,000

Equity

Liabilities

Trade and other payables 195,000

Misc. loans 1,050,000

Total Liabilities 1,245,000

Total equity and

liabilities $ 1,272,000

Difference between assets and liabilities if sold individually on the open market.

Liquidation value

27,000

LO 6


Industry Multipliers

Industry multipliers are standards used to determine the value or worth of a business.

Examples of industry multipliers

MultipliersIndustries

Travel agencies

Retail businesses

Fast food

restaurants

Food distributors

.05 to .1 × annual gross sales

.75 to 1.5 × annual net profit + inventories +

equipment

.5 to .7 × monthly gross sales + inventories

.3 to .5 × annual gross sales, or .4 × monthly

gross sales + inventories

1 to 1.5 × annual net profit + inventories +

equipment

LO 6


Discounted Cash Flow Method (10-year life span)

Discount rates Cost of capital

10%

Purchase price (outflow)

Cash inflows

Cost of capital

Hurdle rate

Net present value

Sale of the business (inflow)

Cost of capital

Hurdle rate

Hurdle rate

20%

The offer

price

$ __________

$ __________

$ __________

$ __________

$ __________

$ __________

$ __________

$ _________ X ________

$ _________ X ________

$ _______ X ________

$ _________ X ________

$ __________

- 3,625,000

519,000 6.1446 + 3,189,047

519,000 4.1926 + 2,175,907

6,000,000 .38554 +2,313,240

+ 969,0606,000,000 .16151

+ 1,877,287 - 480,033

IRR 17.2%

$ __________

- 3,625,000 $ __________3,144,967

0

If you want to make a

20% IRR

LO 6


Going-Concern Value (using the capitalization rate)

Capitalization Value

Cash flow from operations $ 519,000

(from Slide 12-11)

Divided by capitalization rate* ÷ 20%

Going-concern value (present value) $2,595,000

*Capitalization rate represents the required rate of return for the company, which is based on a number of subjective factors and conditions at the time of the valuation.

Company will be sold as a viable business generating a cash flow of say $519,000/year forever.

Going-concern value

LO 6


Market Value of Publicly Traded Companies

Number of shares outstanding: 50,000

Company’s net worth: $2,000,000

Book value of each share: $40.00 ($2,000,000/50,000)

Shares are trading at: $50.00

Market value of the company: $2,500,000 ($50.00 × 50,000)

LO 7


Project Return: Investor’s Perspective

Step 1: Cash flow forecast

Step 2: Residual value of the forecast period

Step 3: Estimated market value

Step 4: Investor’s return (40% investment in the business)a) Before taxb) After tax

LO 8


Projects: Investor’s (Venture Capitalist) Perspective

Investors are looking for a Winning Combination!

Products/Services (%)(the horse)

Management Team

(the jockey)

LO 8


2010 2011 2012 2013 2014

Cash flow from operations $ 519 $ 800 $ 900 $1,200 $1,450

Investment in non-current assets (1,200) (400) (400) (300) (300)Incremental working capital (200) (200) (200) (200) (200)

Sub-total (1,400) (600) (600) (500) (500)

Net cash flows (881) 200 300 700 950

Discount factor @ 20% .83333 .69444 .57870 .48225 .40188Present values ($ 734) $ 139 $ 174 $ 337 $ 382

Cash Flow Forecast (Step 1)This method determines the net present value of the projected

discretionary annual cash flows.

NPV +$ 298


Residual Value of the Forecast Period (Step 2)

Forecast of residual value in 2014

Cash flow $ 1,450

Investments (500)

Net cash flows (from Slide 12-20) 950

Capitalization rate @ 18% ($950,000 ÷ 18%) $ 5,278

×

Present value factor @ 20% .40188

Present value of the residual value $ 2,121

This step determines the residual value of the company after the forecast period is over.


Estimated Market Value (Step 3)

Forecast of discretionary cash flow $ 298 (Slide 12-20)

Add: residual value 2,121 (Slide 12-21)

Estimated fair market $ 2,419

value of the shares

This step determines the residual value of the company after the forecast period is over.

Estimated fair market

value


2009 2010 2011 2012 2013 2014

A. Investment return before taxes --- --- --- ---

Initial investment ($ 600) --- --- --- ---

Cash distribution to investors (Slide 12-20) $ 950 Multiplier 8.0 Total value at exit 7,600

Investor’s required share (40%) --- --- --- 3,040 Initial investment ($ 600) Total discounted cash inflow $ 600 $ 3,040

Investor’s Return—Before Tax (Step 4)This method takes into account the discounted value of the future cash flows to calculate the investor’s return.

Before-tax return to investor 38.34%


B. After-tax return Proceeds received on exit $3,040 Initial investment (600) Capital gain on investment 2,440

Taxable portion (75%) 1,830 Investor’s tax payable (50%) 915

Gross proceeds received on exit 3,040 Investor’s tax payable 915

Net after-tax proceeds to investor $ 2,125

Investor’s Return—After Tax (Step 4)


2009 2010 2011 2012 2013 2014

Initial investment ($ 600) --- --- --- --- ---

Total value at exit

Net after-tax proceeds to investor --- --- --- --- --- $ 2,125

Total cash flowsInitial investment ($ 600)Total cash flows $ 600 $ 2,125

After-Tax Return Calculation

After-tax return to investor 28.78%

Documents

Copyright © 2014 Nelson Education Ltd. 12–1 PowerPoint Presentations for Finance for Non-Financial Managers: Seventh Edition Prepared by Pierre Bergeron